A couple years back, Federal Reserve Board chairman, Alan Greenspan, started dropping interest rates to cool off our “overheating” economy. Over a two year period he incrementally dropped rates about a dozen times.

With each reduction, borrowers presumed that his actions would have an immediately impact consumer interest rates. Occasionally, some were unpleasantly surprised to learn that mortgage interest rates actually increased immediately after the Fed’s reductions.

Recently, Greenspan increased interest rates by a quarter-percent and most mortgage rates took a dip. Were you surprised? When you comprehend what I’m sharing with you today, you will never again wonder why mortgage rates change in a direction opposite the direction of the Federal Reserve’s changes.

Today’s lesson: The Federal Reserve does not dictate your mortgage rates. It does, however, set a key interest rate called the Federal Funds Rate—-the interest rate that the Federal Reserve charges its member banks for overnight loans. It is not the interest rate that consumers get for 30-year mortgages.

Over time, the aggregate changes to this key interest rate impact lenders’ decisions on how much to charge their clients—-that would be us-—for their loan products. If the big bankers feel that the money they borrow from the Federal Reserve might get more expensive, they will raise their rates. Conversely, if they anticipate cheaper money down the line, they may give us consumers a break.

The Wall Street investors also play an important role in how Federal Reserve actions impact our mortgage interest rates. As the investment markets ebb and flow, investors constantly monitor the economic factors that may impact their buying and selling decisions. Their decisions ultimately have an impact on mortgage rates. If they guess wrong, they make adjustments.

Prior to his recent rate increase, many investors felt that Greenspan was going to increase rates more than he actually did, and the market prices (and mortgage interest rates) already reflected their sentiment. When he only changed the Federal Funds Rate by half what most investors expected, it was relatively “bad news” indicating perhaps a slower-than-expected recovery, and fixed-rate mortgage interest rates dropped.

Timothy Phillips is a mortgage banker and newspaper columnist.  Homebuyers should always consult a professional for guidance specific to their situation.

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